A securities trading mechanism can be thought of as a set of protocols that translate a group of investors' latent demands into realized prices and quantities.
Batch auctions are often used as the blueprint trading mechanism for new, automated trading systems such as that disclosed by U.S. Pat. No. 5,873,071 to Ferstenberq et al. and the systems in use by the Arizona Stock Exchange (“AZX”) and the Pacific Stock Exchange (“PSE”). A batch auction is a type of financial market transaction whereby a series of traders simultaneously buy or sell one or more securities at an agreed upon price for each security.
The Ferstenberg et al. patent discloses a method and system for performing off-market intermediated trades of financial securities using periodically conducted batch auctions. In the Ferstenberg system, trades executed during each auction cycle are transacted at a price set equal to the midpoint of the bid-offer spread as quoted by the underlying primary market for the security. The POSIT™ electronic trading system operates in a similar manner to that described in the Ferstenberg patent. Order requests, containing one or more trade orders for one or more assets, are entered into the POSIT system and the trade orders are matched, or “crossed.” The matching attempts to satisfy as many of the trade orders in the system as possible. Once the matching is complete, all matched trades within the system are executed at a price equal to the mid-point of the most recently quoted bid-offer spread.
The Arizona Stock Exchange (“AZX”) operates solely in a batch auction market format. The AZX has a high degree of transparency in that traders are permitted to view a large portion of the order book prior to a given auction, as well as view beforehand the exact price at which trades would occur. Trade price for each security traded in the auction is selected from one of three prices dictated by the underlying primary market for that security; the highest volume maximizing price, the lowest volume maximizing price, or the mid-point of those two. If bids outweigh offers, then the higher offer price is used. Conversely, if offers dominate, then the bid price is used for the auction. Only if supply and demand are exactly equal, the mid-point of the quoted spread is used as the auction price. Collectively, these attributes put may put traders at informational disadvantages or lead to “gaming” (price manipulation by traders), thus preventing accurate price formation and discouraging order entry.
The OptiMark™ electronic trading system employed by the PSE conducts repeated batch auctions over the course of a market day similar in manner to the AZX, but offers less transparency in that the order book is kept confidential. The OptiMark system generates multiple prices for each security traded in each auction such that, for example, all sellers of a particular stock during a given auction are not given the same price. This result is very undesirable to traders, especially when large blocks of shares are traded as is commonly done in batch auctions.
U.S. Pat. No. 6,012,046 to Lupien et al. discloses an electronic securities trading system for crossing orders based upon a price and quantity satisfaction profile specific to each trader. Participating traders submit such a profile in two-dimensional matrix form for each stock they desire to trade in. This matrix is used by traders to specify relative pricing satisfaction information for each stock, and trades are conducted at a price determined from the relative pricing information. The Lupien patent, however, teaches an allocation of the exchanged stock shares among traders based upon time and price priority of the orders. This priority feature often causes the inherent drawback of disparities in fill rates and prices among participating traders which are undesirable in the financial community. Furthermore, the complexity of the order entry process, including the completion of a price matrix for each asset desired to be traded and the lack of market order support, makes such a system unfriendly to traders.
U.S. Pat. No. 5,950,176 to Keiser et al. discloses an electronic securities trading system which uses a computer program to project price movement of securities and set suggested prices for trading in continuous trading markets. This system however does not solve the problems attendant in batch auction methods and systems where providing optimal price determination is hampered by gaming and low liquidity.
The prior art approaches to setting the transaction prices of securities during batch auctions have numerous drawbacks. The existence of order books having high levels of transparency and different execution priority rules, as used by the AZX, produce undesirable disparities in fill rates, discourages order entry and may lead to gaming. An additional drawback of such a batch auction design is that it often is not sufficient to produce accurate pricing in low liquidity, high volatility markets as is present for thinly traded stocks. Price discrimination among traders within a single auction based upon their order types and the use of highly complex order formats, as done by the PSE OptiMark system and the Lupien patent, can cause dissatisfaction among participating traders with the outcome produced by the auction system.
Due to the above-mentioned and other drawbacks, there remains a need in the art for improved price setting methods and systems to sufficiently and efficiently conduct batch auctions of financial securities in financial markets.